TOPICS > Economy

Report Unearths Regulatory Failures in IndyMac Case

December 23, 2008 at 6:15 PM EDT
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Financial regulatory efforts apparently failed in the case of IndyMac, which was reportedly allowed to alter records to appear stronger than it was shortly before the sub-prime meltdown. Analysts take a closer look.
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JEFFREY BROWN: As the subprime meltdown cascaded this summer, the government had to step in and seize control of IndyMac, a California bank. But a new investigation finds that, two months before the FDIC stepped in, a different government regulator may have allowed IndyMac to alter its records to appear to be in better financial health than it really was.

For more, we turn to Karen Shaw Petrou, managing partner of the consulting firm Federal Financial Analytics. She advises financial service executives on political and regulatory risk.

And Binyamin Appelbaum, banking reporter for the Washington Post.

Well, Binyamin, first, who was this regulator? And what is he alleged to have done?

BINYAMIN APPELBAUM, Washington Post: His name is Darrell Dochow. And he was the senior official for the Office of Thrift Supervision in the western United States.

And what apparently happened is that IndyMac Bank Corp., which was a large California mortgage-lender, went to Mr. Dochow in May of this year and said to him, “We would like to alter our financial filings. We would like to include money that we have received in May in a tally of the money that we had in March.” And that had the effect of making the company appear healthier than it actually was.

And Mr. Dochow said, yes, you can do that. He told them it was OK to falsify those records. The company did it, gave the appearance that it was healthier than it actually was, and two months later it failed.

This is all according to a new investigative report by the inspector general of the Treasury Department.

JEFFREY BROWN: The bank went to him and said, “We’d like to do this,” knowingly that it was falsifying information? Is that what it looks like?

BINYAMIN APPELBAUM: According to the inspector general, that’s what it looks like. And he went on to say that other banks did the same thing, that this regulatory agency allowed other banks to do the same thing.

JEFFREY BROWN: Let’s come back to the larger issue here, but, Karen Petrou, first, on this case, so if the bank is able to make itself look like it’s in better shape than it is, why is that so important in this particular case? What happened?

KAREN SHAW PETROU, Federal Financial Analytics: It’s like any of us saying to the bank, “I really wish I had had my checkbook balanced three months ago, but now I’ve got some money, so would you please count it towards my January balance?”

It creates a false picture of your safety and soundness. And in IndyMac’s case, that was particularly troublesome, because OTS should have known — it was evident from a great deal of public information that this bank was in dire circumstances at the very point at which it was being given a pass on its capital account.

IndyMac was failing anyway

Binyamin Appelbaum
The Washington Post
This bank is estimated to cost the FDIC $8.9 billion to clean up. We don't know what the tally would have been if FDIC had acted quicker, but they believe it would have been smaller.

JEFFREY BROWN: Well, is there any evidence that what happened with this regulator either led to its failure or delayed -- what are the implications of it, in terms of its failure?

KAREN SHAW PETROU: It was failing anyway. It was engaged in a lot of very high-risk mortgage activity that never should have been allowed, and that was the proximate predicate cause for its failure.

This backdating may have delayed recognition of that and certainly prevented the FDIC from taking a look. And the longer you delay recognition of a troubled bank, the more a failure will cost. But the failure was happening for far larger reasons, regardless of this one act.

JEFFREY BROWN: Can you add anything to that, Binyamin, in terms of the impact?

BINYAMIN APPELBAUM: Yes, I mean, it made the failure more expensive, in all probability. When a bank is in its death throes, it needs to -- you know, when it tries to borrow money, it needs to pay more to borrow money. It pledges assets as collateral.

Imagine a family in financial trouble that hocks the family jewels, that sells their car, that, by the time people show up to repossess what's left, there's not much left. And in this case, this bank is estimated to cost the FDIC $8.9 billion to clean up. We don't know what the tally would have been if FDIC had acted quicker, but they believe it would have been smaller.

JEFFREY BROWN: Help our audience and both of you -- I'll start with you, Karen -- understand the relationship between a bank like IndyMac -- and we're now going to get into -- this is more systemic -- but the banks and OTS, the Office of Thrift Supervision.

Is it an adversarial relationship? Is it a friendly relationship? What is the regulator supposed to be doing and how often?

KAREN SHAW PETROU: It should be neither adversarial nor friendly, but it should be professional, disciplined. The regulator should double-check. It is the guardian of the public trust. And the agency OTS is a primary supervisor that defends the FDIC's interests as the deposit insurer.

But when there is a sign of trouble, in my opinion, then the bank primary supervisor should show no quarter. They must go in, and they should act -- if they need to make a mistake -- if they're going to make a mistake, it should be one of acting too quickly.

JEFFREY BROWN: What would you add to that?

BINYAMIN APPELBAUM: Well, I think it might help just to step back and say that this agency, the OTS, was responsible for regulating many of the institutions at the heart of the financial crisis.

Washington Mutual, which was the largest failed bank in American history, was regulated by them. The unit that brought down AIG was regulated by them. The unit that brought down Wachovia was regulated by them. So this is a very important agency, and its role in this crisis is really important.

And their relationship with these banks was, in the minds of many critics, far too close. Instead of acting as a cop, they tilted over and acted more as a consultant.

They took a concern for the health and prosperity of these institutions. They advertised themselves as working cooperatively with the institutions they regulated. They described those institutions as clients. And that just raises a lot of questions about how you regulate institutions when you're treating them that way.

Some suspect systemic failings

Karen Shaw Petrou
Federal Financial Analytics
I think this is shocking. That one engaged in this, let alone more, is truly a wakeup call about systemic problems in the bank supervisory network.

JEFFREY BROWN: It's the Treasury Department's inspector general who's raised the question, I guess, about whether this was -- how much this goes beyond IndyMac, right? Do we have many details yet about how far it goes, how systemic it is, how it worked?

BINYAMIN APPELBAUM: Well, I was told by a congressional aide who attended a briefing conducted by the inspector general that the inspector general was asked if it was fair to describe this as systemic, and he said, "Yes."

What the report actually says is that a number of other institutions -- we don't know how many, we don't know which, we don't know when -- engaged in the same type of conduct, falsifying financial records.

JEFFREY BROWN: Karen, do you know any more of that or have a sense of how systemic a problem like this would be?

KAREN SHAW PETROU: No, but I think this is shocking. That one engaged in this, let alone more, is truly a wakeup call about systemic problems in the bank supervisory network.

JEFFREY BROWN: Another glaring thing here is that this particular regulator had been involved in a similar case during the savings and loan scandal with Charles Keating, right?

BINYAMIN APPELBAUM: This was really fascinating.

KAREN SHAW PETROU: That's right.

JEFFREY BROWN: Binyamin, tell us about this.

BINYAMIN APPELBAUM: Yes, Darrell Dochow was a senior federal banking regulator in the late 1980s during the savings and loan scandal. And Congress found -- a congressional investigation found that he delayed regulation of Charles Keating's savings and loan, Lincoln Savings and Loan. He prevented regulators from moving in quickly, from taking proper action, from recognizing its problems.

That, too, had the effect of making that failure more expensive, so it's like watching history repeat itself to a considerable respect.

JEFFREY BROWN: Yes, so the obvious question, Karen Petrou, is how in the world does that -- is it allowed to happen twice, the same person?

KAREN SHAW PETROU: It is a question. It speaks to an internal culture with serious problems.

I think Binyamin's point about the client relationship is very, very troublesome. This particular individual reportedly persuaded a very large troubled institution, Countrywide, to switch its charter from a regulator -- the Office of the Comptroller of the Currency -- that was starting to get tough and to move over to the Office of Thrift Supervision.

And there are at least suggestions that the big job that this gentleman held at the point of the IndyMac decision was sort of a bonus. We cannot regulate like that. I mean, that is just deeply, deeply troubling.

Conduct potentially criminal

Karen Shaw Petrou
Federal Financial Analytics
When you take more risk, you must post more capital. We have laws about enforcement actions. None of these were followed. We're really repeating a very unfortunate history without taking into account any of the lessons that we thought we'd learned.

JEFFREY BROWN: Binyamin, what happens to him now? He's been demoted again, I guess.

BINYAMIN APPELBAUM: He's been removed to Washington to head human relations at this agency and to work on special projects while this inquiry unfolds. And they've not said more than that about his future...

JEFFREY BROWN: But is there a potential criminal charge here?

BINYAMIN APPELBAUM: I wouldn't want to speculate on that. I mean, it can be a crime to falsify financial records. Who that would fall on remains to be seen.

It is the case that this company, you know, used the same information not only in the filing with financial regulators that is the subject of the investigation, but also in its SEC filings. And the same problems do potentially raise criminal issues, but regarding whom I wouldn't want to say.

JEFFREY BROWN: But, Karen Petrou, you're saying that the larger issue here is, how do we make sure this didn't happen in the future systemically?

KAREN SHAW PETROU: I agree. I mean, we went through the S&L crisis. We spent hundred of billions of taxpayer dollars there and on bank failures on the time. We passed two huge laws in 1989 and '91. We had investigations on issues like prompt corrective action. When an institution shows the earliest signs of problem, the regulators are required by law to intervene.

We have laws about capital. When you take more risk, you must post more capital. We have laws about enforcement actions. None of these were followed.

We're really repeating a very unfortunate history without taking into account any of the lessons that we thought we'd learned.

JEFFREY BROWN: All right, Karen Shaw Petrou and Binyamin Appelbaum, thank you both very much.

KAREN SHAW PETROU: Thank you.